Hedge Funds With(out) Edge

56 Pages Posted: 25 Jul 2023 Last revised: 16 Jan 2024

See all articles by Eric Wilson

Eric Wilson

McMaster University - Michael G. DeGroote School of Business

Date Written: July 18, 2023

Abstract

Estimates of alpha from reduced-form factor models are an incomplete measure of hedge fund performance. By focusing solely on alpha, we are failing to capture important return variation during market dislocations. The omission of this return variation from performance measures leads to poor out-of-sample (OOS) performance. To address this issue, I introduce a new measure, Edge, and benchmark, Short VIX, of hedge fund performance that I argue more accurately reflects the skill of a hedge fund manager. A hedge fund manager that is able to generate alpha without exposure to market downside risks is determined to possess Edge. With the introduction of this measure, I document a new finding in the hedge fund literature: Hedge funds can be separated, ex-ante, into two groups, with respect to Edge. Only 3% of hedge funds possess Edge. OOS, hedge funds with Edge have both higher sharpe ratios and positive skewness while those hedge funds without Edge have lower sharpe ratios and negative skewness.

Keywords: Hedge Funds, Edge, Market Dislocations, Skill, Performance Evaluation, VIX Futures

JEL Classification: G11, G12, G14, G23

Suggested Citation

Wilson, Eric, Hedge Funds With(out) Edge (July 18, 2023). Available at SSRN: https://ssrn.com/abstract=4513205 or http://dx.doi.org/10.2139/ssrn.4513205

Eric Wilson (Contact Author)

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

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